The path to 7000 has not been straightforward, and the arrival of the global financial crisis on Australian shores in late 2007 kept investors waiting a decade to reclaim pre-GFC territory. The market fell to as low as 3145 points in 2009 and did not return to the 6000 mark until late 2017.
The trade deal between the US and China ends almost two years of escalating trade tensions between the global superpowers which roiled markets as President Donald Trump raised the stakes with mounting threats.
The US Federal Reserve cut interest rates for the first time since 2008 in 2019 to cushion the impact on the world’s largest economy.
News of a truce first emerged in December, and along with the election of UK Prime Minister Boris Johnson, who intends to take the country out of Europe by the end of this month, represented a stabilisation in global geopolitical risks.
“Once we had Brexit and the trade deal, people are looking up and seeing that there’s not that many negatives,” said Julian Beaumont, chief investment officer at Bennelong Australian Equity Partners.
“The consensus view is that the global economic picture is improving [and] macroeconomic factors are building up to improve investor confidence.”
Bullish sentiment has helped the S&P/ASX 200 Index to gains of just over 5 per cent so far this year following an almost 20 per cent advance in 2019, its best year in a decade.
But fund managers agree the returns have been fuelled by low interest rates rather than any expectation of a strong improvement in earnings or economic growth.
The reality is that earnings were pretty mediocre last year and that didn’t stop the market going up.
— Martin Conlon
The past year was “phenomenal” said Paul Taylor, head of Australian equities at Fidelity International, noting the lack of earnings growth is a relatively unusual scenario in markets.
According to Morgan Stanley, 2019-20 earnings per share growth stands at just 3.8 per cent for the broader market.
“If you look at 2019, it was really a cost of capital market rally,” he said. Investors were eyeing falling bond yields – the 10-year Australian government bond yield hit a record low 0.876 per cent in 2019 – and applying those assumptions to discounted cash flow valuations.
The impetus for the market’s gains “has been [low] interest rates and increasing central bank intervention,” Mr Conlon said.
“The reality is that earnings were pretty mediocre last year and that didn’t stop the market going up,” he said.
In accepting that bond rates have underpinned gains, investors said that had unleashed a stockpicker’s market littered with excessive valuations and downgrade risk.
“Last year we had highly accommodative monetary policy from all the global central banks,” said Geoff Wilson, chairman of Wilson Asset Management. “Pumping money into the system has been beneficial for financial markets.”
Investors facing the prospect of super-low interest rates and little or no return from cash in the bank or term deposits have been looking elsewhere for yield.
“The equity market really stands out on a relative basis,” Mr Taylor said. “You can get 1.5 per cent in a fixed-term deposit but in equities, investors are still getting a 4 per cent fully franked dividend yield.
“People have to put their money somewhere and the equity market really is the standout,” the fund manager said.
Interest in shares has been reflected in high valuations, which mean industrial stocks are trading at the highest multiples since 1960, according to Macquarie research.
In Mr Taylor’s view, investors are not yet fully factoring in the current risk-free rate of around 1.2 per cent in Australia.
At a very rough estimate, a risk-free rate of around 3 per cent is the dominant input in current models, as investors remain cautious about the longevity of the low-interest-rate environment, he said.
“If we go through 2020 and rates don’t really move, or they move in a band, then there is probably a lot more valuation upside,” the Fidelity manager said.
The gains in the Australian market are largely divorced from the reality of company fundamentals, Mr Conlon at Schroders argued.
“The stocks that put in the best performances are the ones that don’t earn anything,” the famously contrarian fund manager said.
“We remain pretty biased to real economy sectors. We are incredibly cautious on technology and healthcare which don’t have a lot of earnings basis for price gains.”
Most people are complacent about inflation, he added, believing it will remain persistently low. If they are wrong, “that will drive a significant change in stock markets.”
A more inflationary environment would favour the value-style of stock picking over growth.
But, while valuations are stretched historically, “we have never had to deal with rates at 1 per cent. We need to acknowledge that context,” urged Mr Beaumont.
There are still $US11 trillion of negative-yielding bonds on issue globally, although that figure has reduced from $US17 trillion in August last year.
Complicating the outlook is that earnings forecasts don’t improve that much in 2020-21, according to consensus forecasts, which show EPS growth rising to 4.3 per cent.
At the same time, the market is trading on 17.7 times forecast earnings or 25.1 times for industrials stocks, according to Morgan Stanley.
“You can’t just keep going up using valuations,” Mr Taylor said. “At some point, you need earnings growth to come through.”
Two downgrades this week have undermined the euphoria of the sharemarket’s record high: Mosaic Brands, the owner of Noni B, warned that the bushfire emergency had hurt trading, and software group Gentrack blamed Brexit for delayed implementation of its platform, imperilling its profit guidance.